Everybody knows the deal these days on natural gas. E&P companies like Cabot Oil & Gas (NYSE:COG) have been incredibly successful at finding and exploiting new sources of natural gas, but the U.S. energy infrastructure has not shifted as radically. Consequently, inventories are high and prices are low, which has kept a lid on many of the stocks. Although Cabot's near-term valuation wouldn't suggest that it's a compelling buy, I think a longer-term perspective suggests a different answer.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Growth Is Definitely Not the Problem
Cabot is by no means struggling to post impressive-looking production growth numbers. For the second quarter, for instance, the company saw 40% year-on-year production growth - and that was actually disappointing due to infrastructure delays in the key Marcellus region.

Production growth is only part of the story, though. Realized prices were down 48% from last year, and that's an incredibly difficult headwind to offset. Likewise, unit production costs continue to rise (about 13% year on year), and that sent unit profits spiraling down (down 74% from last year's second quarter).

SEE: A Guide To Investing In Oil Markets

A Top-Notch Player
It's not always easy to see the quality of a commodity producer when the commodity in question is under serious pressure. Now, natural gas has rebounded strongly since the spring, buoyed in part by demand from electrical utilities, but still stands below $3 per million BTUs. At this level, it's hard for even the best companies to make real profits.

Nevertheless, Cabot has the markings of an excellent company. The company's finding and development (F&D) costs are among the lowest in the industry, as are its lifting costs. What's more, when you compare its capital productivity to other well-run names like Ultra Petroleum (NYSE:UPL), Southwestern (NYSE:SWN) and Range Resources (NYSE:RRC), Cabot looks quite good indeed, with nearly twice the productivity.

Gas Today and Gas Tomorrow
While Cabot has been exploring liquids-rich asset plays in the Anadarko (where initial Marmaton results have looked quite good) and the Eagle Ford, let's not get carried away. With over 96% of Cabot's 2011 year-end proven reserves in natural gas, this is going to be a natural gas story.

Therefore, it probably goes without saying that the future of natural gas pricing is of central importance to Cabot. Sooner or later, I think prices have to increase. With current prices making it so difficult to make money, many producers have switched over to produce as much oil as possible. At the same time, there are compelling long-term arguments for more gas-fired electricity generation in the U.S.

It's also worth considering the international arbitrage angle. Right now, liquified natural gas imports are going for about $14.50/MMBtu in Japan. That discrepancy creates a lot of incentive to build LNG terminal facilities, and that's actually happening in the U.S. right now - though not at the pace natural gas bulls may like.

SEE: Oil And Gas Industry Primer

The Bottom Line
Cabot's huge position in the Pennsylvania Marcellus, as well as other assets like Utica, Eagle Ford, Anadarko and so on, suggests a lot of potential production growth over the coming years. At the same time, the company's conservative management and cost discipline points to the probability of that being profitable production growth.

Unfortunately, today's numbers don't work out so well. Analysts are still conservative on natural gas prices in 2013 and 2014 and that is compressing EBITDA estimates - making Cabot's valuation appear not-so-compelling. And to be fair, if natural gas prices do stay below $4 or $3.50, it's hard to argue for owning this stock. Taking a longer-term view, though, and assuming that U.S. natural gas prices will close the gap with international prices, Cabot looks like a high-quality way to play a better future for natural gas.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  2. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  3. Stock Analysis

    The Top 5 Platinum Penny Stocks for 2016 (PLG, XPL)

    Examine five penny stocks in the platinum mining business that investors may wish to consider adding to their investment portfolios for 2016.
  4. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  5. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  6. Fundamental Analysis

    4 Predictions for Oil in 2016

    Learn four predictions for oil markets in 2016 including where prices are heading and the key fundamental factors driving the market.
  7. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  8. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  9. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  10. Stock Analysis

    The Top 5 Micro Cap Alternative Energy Stocks for 2016 (AMSC, SLTD)

    Follow a cautious approach when purchasing micro-cap stocks in the alternative energy sector. Learn about five alternative energy micro-caps worth considering.
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center